Really!?! With Dougie

This commentary originally appeared at 8:28 a.m. EST on Feb. 20 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

All the market optimism surrounding rising retail fund flows into U.S. stock funds and heightened M&A activity brings us to a segment in my diary that I like to call Really!?! With Dougie (a takeoff on Really!?! With Seth & Amy, an old Weekend Update routine on "Saturday Night Live."

Really!?! Mr. Market?

So individual investors, after taking $400 billion out of domestic equity funds since 2007, have waited to buy into the U.S. stock market until January 2013 after the S&P 500 has more than doubled?

From 2007 to 2012 the S&P 500 saw a total of 40 individual months of price appreciation, 20 of these months experienced negative total equity fund flows. The correlation between monthly S&P returns and domestic equity fund flows is a meager 0.073.

In the 29 months of positive total equity fund flows during that same period, nine of those months had negative SPDR S&P 500 ETF Trust (SPY) returns -- that's 31% of the data points. In the aggregate since 2008 total equity fund flows have been down $400 billion while the SPY has appreciated nearly 75%.

Really!?! Bulls? Really!?!

And those of you who feel that heightened merger and acquisition activity likely presages the next bull market move because it is indicative of an expression of rising business confidence -- Really!?!

An increase in mergers, just like retail investors' inflows into domestic equity funds, is a lagging, not leading, indicator. A rise in M&A activity almost always follows a rising market and rarely leads a rising market.

Really.

The frequency of takeovers tells us nothing about the future direction of the market. It is but a talking point for the bulls.

To all those managements that have now gotten more aggressive in buying back their company's stock and/or are suddenly enticed to acquire: Where were you when the S&P 500 was at 1100, 1200 or even 1300?

One of the more important points made in the above "SNL" parody is that there is little relationship between the price of the S&P 500 and domestic equity fund inflows.

I have long written that the great rotation is a bogus concept and not to count on individual investor.

I prove this with the help of Seabreeze's analyst interns (Nick Pollari and Kelley Hopkins) who have performed an analysis of the relationship between stock prices and fund flows from February 2007 to December 2012.

Below is our research output.

Correlation between monthly S&P returns and:

total equity fund flow = 0.197

domestic equity fund flow = 0.073

total bond fund flow = -0.183

total fund flow = -0.088

R-squared between monthly S&P returns and:

total equity fund flow = 0.039

domestic equity fund flow = 0.005

total bond fund flow = 0.034

total fund flow = 0.008

Covariance between monthly S&P returns and:

total equity fund flow = 0.492

domestic equity fund flow = 0.096

total bond fund flow = -0.066

total fund flow = -0.036

The covariance measures how two variables change together; the strongest covariance is between total equity fund flow and monthly S&P returns. Given that correlation shows the strength of the linear relationship, however, it is hard to come to a conclusion that fund flows and returns are related. The correlation between all variables and S&P returns are close to zero, indicating that the relationship is close to uncorrelated. The R-squared figures note that the regression line does not fit the data well since they are close to zero as well.

Further analysis of the monthly returns over the same time period (71 months) yielded the following data:

Of the 40 months of positive monthly S&P returns, 20 months (50%) experienced a positive S&P return while total equity fund flows were negative for the month.

Of the 29 months of positive total equity fund flows, there were nine months (31%) when the monthly return on the S&P was negative despite positive flows.

Since February 2007, total equity fund flows have been down $480 billion while the S&P (excluding dividends) has appreciated 1.1%. Domestic equity fund flows have been down $616 billion while the S&P (excluding dividends) has appreciated 1.1%.

Since January 2008, total equity fund flows have been down $304 billion while the S&P (excluding dividends) has appreciated 71.9%. Domestic equity fund flows have been down $397 billion while the S&P (excluding dividends) has increased by 71.9%.

The first two points emphasize the lack of correlation between positive S&P returns and equity fund flows. If there was a strong correlation, there would be fewer months of negative S&P returns with high positive fund flows. The latter two points confirm this statement; the S&P appreciated over 70% with high fund outflows.